Alexandria REIT lures biotech investors with lab space, not drugs

The booming biotech sector is putting a premium on lab space, and fund managers are buying in.

One of their favorite targets is Pasadena, California-based Alexandria Real Estate Equities Inc, which owns the largest collection of high-end lab space in such research clusters as San Diego, San Francisco and Cambridge, Massachusetts. A total of 64 mutual funds and hedge funds have reported adding shares of the company to their portfolios in the current quarter, a 56 percent jump from the quarter ending in September, according to Morningstar data.

Those buys come on the heels of a steep decline in biotech stocks generally because of concerns that legislation could bring caps to drug prices. Shares of Alexandria fell by as much as 10 percent during the sell-off, while the broader Nasdaq biotechnology index tumbled as much as 24 percent before hitting a low at the end of September.

Fund managers say that they pounced on shares of a company they see as uniquely positioned to benefit from an aging U.S. population that will spur the development of new drugs. U.S.-based life science firms have added approximately 80,000 employees since 2011, according to real estate research firm JLL. That has helped push rents for lab spaces up by 7.4 percent over the last year in Boston, the nation's most expensive market for life science firms, while San Francisco rose 16.9 percent and San Diego is up 15.5 percent.

And investors who go long on lab space instead of the biotech companies that use it don't have to worry about which drugs will emerge as winners and which won't.

"They own the best real estate in the best healthcare-focused markets in the country," said Jeffrey Kolitch, whose $1.8 billion Baron Real Estate fund is the top-performing real estate fund over the last five years, according to Morningstar. Kolitch, who has owned shares of the company since 2008, added to his position this fall, according to a September quarterly filing. He would not say at exactly what price he added shares.

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With its fortunes directly tied to the health of tenants including Biogen, Novartis, Eli Lilly and Roche, Alexandria has long traded in tandem with the pharmaceutical and biotech industries.

At the same time, the shares are benefiting from the acquisition of BioMed Realty Trust - its chief competitor among life-sciences focused REITs - by private equity group Blackstone for $4.8 billion on Oct. 8. Blackstone paid a 24 percent premium for BioMed's assets, which Kolitch estimates were in less desirable locations than Alexandria's and suggests that Alexandria would fetch a higher valuation.

To be sure, the company's strong connection to the biotech sector cuts both ways. Shares of Alexandria are down 3.5 percent over the last three months, compared with a 3.2 percent gain for the REIT sector as a whole, largely due to its connection to tenants such as Gilead Sciences, whose shares were down at one point as much as 22 percent for the year before rebounding.

And it's no bargain. Shares of Alexandria, which reports its next quarterly results on Nov 3, trade at a trailing price-to-earnings ratio of 119, about double the average U.S. REIT. Its short interest - a measure of how many investors are betting that it will fall - is a low 1.9 percent, according to Thomson Reuters data and it is paying a 3.4 percent dividend.

PUSH INTO TECH

Some analysts say that they are cautious about the company's expansion plans as it increasingly moves away from its profitable core business of lab space and into traditional office space leased by tech startups.

Alexandria announced last year that it had formed a joint venture with car-booking service Uber Technologies [UBER.UL] to build its new headquarters in San Francisco's Mission Bay neighborhood. In August, Alexandria announced that it had leased a 150,000 building to Pinterest in San Francisco's South of Market neighborhood. Overall, the company has about 3.1 million of square footage leased in the San Francisco region.

"When you talk to brokers in San Francisco, you're hearing that over the last six to nine months companies are taking space that they don't need today so they can expand in the future," said David Rodgers, an analyst at Robert W. Baird & Co., who downgraded Alexandria to "neutral" in September, according to Thomson Reuters data. "We're not calling the end of the tech boom yet, but there's a lot of planning based on the growth plans of tech companies who may not need it."

Anthony Paolone, an analyst at JP Morgan Securities, upgraded his rating on the company to "overweight," however, based in part on the company's holding of real estate in the tech centers of San Francisco and Seattle. He estimates that 83 percent of the company's $2.7 billion in developments have already been pre-leased, and that the stock trades at a discount of approximately 10 percent to what its underlying real estate is worth.

"While you are getting later in the cycle, we are comfortable that these are folks that are going to show up and pay rent. It's Pinterest, Uber, Bayer. We're not experts in those spaces but they seem to us like good potential tenants," he said.